2023-05-01 13:15:46 ET
Summary
- AFC Gamma is paying out an 18.5% dividend yield from a portfolio of commercial property loans to the cannabis industry.
- The mREIT has seen its discount to tangible book value widen in recent quarters as the market reacts to a still-rising interest rate environment and broader cannabis headwinds.
- A payout ratio of 90% and a discount to tangible book value of 27% have set the backdrop for AFC's total returns in 2023.
AFC Gamma ( AFCG ) last declared a quarterly cash dividend of $0.56 per share , in line with its prior payout and for an 18.5% forward yield. The West Palm Beach, Florida-based company is a commercial real estate lender with a distinct specialization, but not exclusively in loans to state-licensed cannabis operators. The mortgage REIT provides bridge loans and direct loans in the $5 million to $100 million range. As of the first of March 2023, it had commitments of $421 million and an outstanding principal balance of $391 million. The fat yield is the prize here and this has moved to new highs on the back of the collapse of cannabis sentiment overlayed with the pullback of REITs more broadly in a direct reaction to the rising Fed funds rate environment.
AFC is down 27% over the last year with the bulk of this pullback taking place over the last four months since the start of 2023. Is this a yield trap? Possibly. The US cannabis industry remains on the cusp of federal legalization, but its constituents have faced a dearth of liquidity on the back of a deepening cannabis bear market. The liquidity crisis engulfing the industry could get worse with at least ten publicly traded MSOs collectively owing $500 million in unpaid taxes to the IRS. All face less than a year cash runway in the event that they were forced to fully pay back their tax bills.
The risk for AFC Gamma here is that it's making loans to an industry potentially set to face rising bankruptcies and that its loan portfolio could realize a level of impairment through 2023. The externally managed mREIT, which briefly considered internalization last year, faces a difficult 2023 even as its recent quarterly results continue to record strong growth. The widening discount to tangible book value ("TBV") is the second prize here as a move back up to its intrinsic value would represent a significant level of shareholder value creation.
A Widening Discount To Tangible Book Value
AFC's loan portfolio had 13 loans as of March with loan maturities ranging from 2023 to 2027 and with a blended cash interest rate of 14.4% set against a 21% yield to maturity. Around six of these loans were floating with an aggregate value of $220 million, around 56% of their total principal balance. Critically, this means AFC partially stands to benefit from the rising rate environment as the cost of funding its loans also moves up.
AFC reported net interest income of $19.7 million for its fiscal 2022 fourth quarter, a beat by $1.51 million on consensus estimates and growth of 52% over the year-ago comp. This growth was driven by an increase in commitments over the year-ago period. AFC is currently reviewing a further 14 cannabis deals. The mREIT reported fourth-quarter non-GAAP distributable EPS of $0.62, a beat by $0.06 on consensus estimates and growth from $0.52 in the year-ago comp. Whilst the dividend is fully covered as it formed a 90.3% payout ratio, the high percentage opens up the pay-outs to more risk. This is set against a discount to TBV that stood at 27% as of the end of the fourth quarter.
A Precarious 2023 As Commitments Trend Down
TBV per share at $16.65 was up by around $0.04 over the year-ago period, but down sequentially from $17.06 in the third quarter. The company's commitments are also trending down, peaking at $502 million in the third quarter and falling by around $81 million to $447 million as of February.
Whilst the current macroeconomic conditions and the implosion of commercial real estate will require greater loan origination standards, the mREIT will need to ramp up its loan book to prevent distributable EPS from falling behind its year-ago comps in future quarters. The US cannabis industry is still set for growth even against the current collapsing sentiment with legal cannabis sales expected to reach $71 billion in 2030.
I like the dividend yield here, but the relatively concentrated portfolio and the tight payout ratio against falling loan commitments open up the payout to heightened risk. Critically, a singular default on a larger loan could disrupt their dividend and open up the company to trade at an even greater discount to TBV. Against this, I'm rating AFC as a hold. The mREIT is set to publish fiscal 2023 first-quarter earnings later in May and shareholders should be on the lookout for growth in commitments and whether TBV continued to fall sequentially. I'd be open to starting a position if both of these trends were positive. 2023 will likely see constrained investor enthusiasm for cannabis picks, but the long-term play for AFC against the disruption is stable dividends and an eventual return to trade on par with TBV.
For further details see:
AFC Gamma: The Fat 18.5% Yield From Cannabis Could Be At Risk